25 April 2017

Malaysia Looks to Digital Sector as Electronics Demand Declines

With its electronics sector suffering from falling investment and growing competition, Malaysia sees digital infrastructure as the likely key its future economic success, with plans in place to launch the world's first Digital Free Trade Zone.

Is the Malaysian electronics sector now past its sell-by date?

Is the Malaysian electronics sector now past its sell-by date?

Malaysia first ventured into the electronics sector back in the 1970s, though it wasn't until the 1980s that it really became a force to be reckoned with. This was largely on account of hefty investment on the part of a number of US, Japanese, Korean and Taiwanese companies, including Samsung, Panasonic, Sony, Intel and Hewlett Packard. For the most part, this saw such companies establishing facilities in one of the country's free trade zones, either in Penang in the north or Selangor in the east.

At a time when the global electronics market was beginning to soar, Malaysia offered low costs, cheap labour and weak unions. It also benefitted from being a strategically significant export location, with its ports having direct access to the Malacca Strait.

Its focus was very much on consumer electronics, electronic components (with semiconductors, integrated circuits, transistors and valves contributing around 40% of electronics exports), industrial electronics and electrical goods. Electronics quickly became Malaysia's lead manufacturing sector, with the country supplying several key export markets, notably Japan, China, Hong Kong, Singapore and the United States.

In 2010, electronics was named as one of the 12 National Key Economic Areas in Malaysia's Economic Transformation Programme (ETP), a government initiative designed to give the country high-income economy status by 2020. One of the principal aims of the ETP was to drive diversification "away from electronics manufacturing and towards higher-value activities, such as design, assembly, packaging and the provision of total solutions." In order to achieve this, it set out the need for establishing five distinct clusters – manufacturing services and design, advanced assembly, industrial and integrated electronics, advanced materials and wafer technology.

As a sign of the success of the initiative, by 2014 the electrical, electronic and optical products sector accounted for 33.4% of Malaysia's export revenues, according to figures released by the Ministry of International Trade. A the same time, the country's high level of electronics imports – notably semiconductors, circuits, transistors and valves, which represent more than 25% of the country's total imports – indicated that assembly remained Malaysia key role within the global supply chain. With the country's currency – the ringgit – remaining weak, overall profitability was continually put at risk by fluctuations in the exchange rate.

Of late, the country has suffered from an overall slowdown in its rate of economic growth, although there are signs of improvement. For 2017, Malaysia's Institute of Economic Research, for instance, is predicting a 4.5% growth in GDP, slightly up from the 4.2% recorded in 2016.

The country's recent problems are largely on account of the relatively modest performance of its electronics sector. In the first three quarters of 2016, Malaysia exported RM207.9 million (US$46.9 million) worth of electronics products (from total manufacturing exports of RM469.3 million), compared to RM203.8 million in 2015. While the output of integrated circuits (27 million) and semiconductors (12.2 million) showed year-on-year growth, both were well down on 2013 levels. Television output in 2016, meanwhile, was less than half that of 2013, with only electronic transistor output remaining stable, according to Bank Negara's December 2016 Monthly Statistical Bulletin.

Overall, the level of investment has also stagnated, largely on account of rising costs, comparatively low productivity, weak demand and the emergence of a number of highly competitive alternative locations across South East Asia. As a result, Malaysia's manufacturing, services and primary sectors attracted just RM150.8 billion of investment in the the first nine months of 2016, a 3.7% reduction year-on-year. At the same time, disk-drive manufacturer Seagate and Western Digital announced plans to move their operations from Penang to Thailand, while production also ceased at the Rubicon Sapphire Technology factory in central Malaysia.

The problem was exacerbated when several high-profile investments failed to live up to government expectations. In late 2015, Osram announced plans to invest €1billion (US$1.06 billion) in establishing the world's largest six-inch LED chip plant in the northern Kedah province, with completion of the first phase scheduled for 2018. In September 2016, however, it was subsequently reported that the company had diverted much of the proposed funding into manufacturing iris-scanning chips for smartphones and virtual reality systems in its facilities in Germany and China. In the company's 2016 Annual Report, it was later revealed that initial investment in the Malaysian site had been scaled down to €370 million.

Another problem facing the country is its relative shortage of labour. In total, Malaysia has a workforce of around 15 million, notably less than Thailand's 38 million or Vietnam's 55 million in Vietnam. This has posed a problem for all manufacturers, many of which have had to rely on undocumented migrant workers, a situation seen as untenable in the long-term.

With its economy having proving vulnerable to fluctuations in global demand and falling oil prices, Malaysia is now seeking new growth sectors as a buttress against further decline in demand for its electronics output. One area in particular – digital infrastructure – has been identified as a priority with regarding to sustaining employment and driving economic growth.

In recognition of China's success in growing its own e-commerce sector, Jack Ma, the founder of Alibaba, the Hangzhou-headquartered internet giant, was appointed as Malaysia's digital economy Czar back in 2016. The following year, Najib Razak, Malaysia's Prime Minister announced his intention to establish "the world's first Digital Free Trade Zone (DFTZ)".

At present, digital connectivity accounts for around 16% of Malaysia's GDP, with the DFTZ project expected to incentivise digital investors as a way of boosting economic growth and enhancing innovation. To this end, a number of Chinese tech giants – including Alibaba, Huawei and Tencent – have already been courted as possible partner for the DFTZ initiative.

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